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Oil Price Forecasting Using Crack Spread Futures and Oil Exchange Traded Funds

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Oil Price Forecasting Using Crack Spread Futures and Oil Exchange Traded Funds A Service of Leibniz-Informationszentrum econstor Wirtschaft Leibniz Information Centre Make Your Publications Visible. zbw for Economics Choi, Hankyeung; Leatham, David J.; Sukcharoen, Kunlapath Article Oil price forecasting using crack spread futures and oil exchange traded funds Contemporary Economics Provided in Cooperation with: University of Finance and Management, Warsaw Suggested Citation: Choi, Hankyeung; Leatham, David J.; Sukcharoen, Kunlapath (2015) : Oil price forecasting using crack spread futures and oil exchange traded funds, Contemporary Economics, ISSN 2084-0845, Vizja Press & IT, Warsaw, Vol. 9, Iss. 1, pp. 29-44, http://dx.doi.org/10.5709/ce.1897-9254.158 This Version is available at: http://hdl.handle.net/10419/141896 Standard-Nutzungsbedingungen: Terms of use: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Documents in EconStor may be saved and copied for your Zwecken und zum Privatgebrauch gespeichert und kopiert werden. personal and scholarly purposes. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle You are not to copy documents for public or commercial Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich purposes, to exhibit the documents publicly, to make them machen, vertreiben oder anderweitig nutzen. publicly available on the internet, or to distribute or otherwise use the documents in public. Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, If the documents have been made available under an Open gelten abweichend von diesen Nutzungsbedingungen die in der dort Content Licence (especially Creative Commons Licences), you genannten Lizenz gewährten Nutzungsrechte. may exercise further usage rights as specified in the indicated licence. www.econstor.eu 29 Primary submission: 16.09.2014 | Final acceptance: 26.09.2014 Oil Price Forecasting Using Crack Spread Futures and Oil Exchange Traded Funds Hankyeung Choi1, David J. Leatham2, Kunlapath Sukcharoen2 ABSTRACT Given the emerging consensus from previous studies that crude oil and refined product (as well as crack spread) prices are cointegrated, this study examines the link between the crude oil spot and crack spread derivatives markets. Specifically, the usefulness of the two crack spread derivatives products (namely, crack spread futures and the ETF crack spread) for modeling and forecasting dai- ly OPEC crude oil spot prices is evaluated. Based on the results of a structural break test, the sample is divided into pre-crisis, crisis, and post-crisis periods. We find a unidirectional relationship from the two crack spread derivatives markets to the crude oil spot market during the post-crisis period. In terms of forecasting performance, the forecasting models based on crack spread futures and the ETF crack spread outperform the Random Walk Model (RWM), both in-sample and out-of-sample. In addition, on average, the results suggest that information from the ETF crack spread market contributes more to the forecasting models than information from the crack spread futures market. KEY WORDS: oil price forecasting, crack spread futures, oil-related exchange traded funds, multivariate GARCH model JEL Classification: C18, C58, G17, Q47 1 Ministry of Strategy and Finance, Sejong Special Self-Governing City, Republic of Korea; 2 Department of Agricultural Economics, Texas A&M University, USA 1. Introduction 1999; Haigh & Holt, 2002; Lanza, Manera, & Giovan- Crude oil is an important energy commodity that is nini, 2005; Serletis, 1994). The emerging consensus vital for most economic activities. Consequently, nu- from these studies is that crude oil and refined prod- merous studies have been devoted to modeling and uct prices are cointegrated. As a result, we should be forecasting crude oil prices. In recent years, the link able to forecast future oil price movements based on between the crude oil and refined product markets information from the refined product markets. How- has been addressed often in the energy economics lit- ever, only a few empirical works have investigated the erature. In particular, several studies have examined ability of refined product prices to forecast the price of the existence of a long-run equilibrium relationship crude oil (see, for example, Gjolberg & Johnsen, 1999; between the prices of crude oil and refined products Lanza et al., 2005; Murat & Tokat, 2009). A deeper (Asche, Gjolberg, & Völker, 2003; Gjolberg & Johnsen, understanding of the relationship between the crude oil and refined product markets and of the predictive Correspondence concerning this article should be addressed to: power of the refined products are indeed worthy of Kunlapath Sukcharoen, Department of Agricultural Econom- investigation and may carry important implications ics, Texas A&M University, College Station, TX 77843, USA, Phone: for energy consumers, producers, investors and poli- +1 (314) 359-8847. E-mail: [email protected] cymakers. www.ce.vizja.pl Vizja Press&IT 30 Vol. 9 Issue 1 2015 29-44 Hankyeung Choi, David J. Leatham, Kunlapath Sukcharoen In this study, we explore the link between the crude model. Second, whereas most of the previous litera- oil spot and refined product derivatives markets and ture, including Murat and Tokat (2009), focuses on ei- examine the ability of the refined product derivatives ther Brent or West Texas Intermediate (WTI) crude oil prices to predict movements in the crude oil price. In prices, we investigate the dynamics of the new OPEC oil and energy markets, the profits of oil refiners, the Reference Basket (ORB) price. The understanding of major participants in the markets, depend largely on the OPEC crude oil price is important given the share the crack spread (the difference between the price of of OPEC’s crude oil production and exports. The U.S. crude oil and the prices of refined products – typically Energy Information Administration (2014) reports, gasoline and heating oil). Because the demand from oil “OPEC member countries produce approximately 40 refiners, whose production decisions are tied directly percent of the world’s crude oil and exports approxi- to the crack spread, largely affect the price of crude mately 60 percent of the total petroleum traded inter- oil (Verleger, 1982; Verleger, 2011), it is possible that nationally.” In particular, the study allows us to answer there is a long-run equilibrium relationship between whether the crack spread price data from the U.S. de- crude oil and crack spread derivatives prices. This rivative markets can significantly explain OPEC crude study therefore examines the existence of long-run oil price movements. In summary, given the limited equilibrium price relationships between the crude oil empirical investigations of the link between the OPEC and crack spread derivatives markets. Specifically, we crude oil spot and refined product derivatives markets, explore the equilibrium price relationships between the results from this study should provide useful in- (i) the OPEC crude oil spot and crack spread futures formation for both oil refiners and energy investors and (ii) the OPEC crude oil spot and Exchange Trad- regarding portfolio investment and risk management. ed Fund (ETF) crack spread. The Granger causality The remainder of this paper is organized as follows. is then used to analyze the lead-lag relationship and Section 2 contains a brief discussion of the theoretical determine whether the crack spread derivatives prices background on predicting oil price movements using are useful for forecasting the movements of crude oil crack spread derivatives. Section 3 describes the data. spot prices. Finally, we compare the forecasting ability Section 4 presents the methodology used in forming of the two crack spread derivatives with that of a con- the forecasting models. Section 5 discusses the empiri- ventional Random Walk Model (RWM). cal results, and finally, Section 6 concludes. Our paper contributes to the existing literature by enriching the understanding of the dynamic rela- 2. Predicting oil price movements tionships between crude oil spot and refined product using crack spread derivatives derivatives prices in the following ways. First, unlike The idea of forecasting oil price movements using many previous studies, we focus on the prices of crude information from the crack spread futures market is oil spot and crack spread derivatives. With the notable based on two different arguments. The first argument exception of Murat and Tokat (2009), our study is relies on the proposition that the price of crude oil among the first to examine the link between the crude largely depends on the demand from oil refiners (Ver- oil spot and crack spread derivatives markets and to leger, 1982; Verleger, 2011). The rationale behind this investigate oil price forecasting models based on in- proposition is that oil refiners are most concerned with formation from the crack spread derivatives markets. the crack spread, and therefore, they cut their levels Unlike Murat and Tokat (2009), we analyze not only of production when the price of crude oil is too high the futures market but also the ETF market. Thus, the compared with the prices of their refined products findings from this study also have implications regard- (i.e., when the crack spread is too low). A decrease in ing which market contributes more to the forecasting production of refined products will, in turn, lower the models. In addition, while Murat and Tokat (2009) price of crude oil
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